Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Lumax Auto Technologies Limited (NSE:LUMAXTECH) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Lumax Auto Technologies's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2022 Lumax Auto Technologies had debt of ₹1.65b, up from ₹984.0m in one year. However, it does have ₹2.07b in cash offsetting this, leading to net cash of ₹421.3m.
A Look At Lumax Auto Technologies' Liabilities
The latest balance sheet data shows that Lumax Auto Technologies had liabilities of ₹4.70b due within a year, and liabilities of ₹644.4m falling due after that. On the other hand, it had cash of ₹2.07b and ₹2.69b worth of receivables due within a year. So its liabilities total ₹576.0m more than the combination of its cash and short-term receivables.
Of course, Lumax Auto Technologies has a market capitalization of ₹17.4b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Lumax Auto Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Lumax Auto Technologies has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lumax Auto Technologies can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Lumax Auto Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Lumax Auto Technologies produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Lumax Auto Technologies has ₹421.3m in net cash. And it impressed us with its EBIT growth of 49% over the last year. So is Lumax Auto Technologies's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Lumax Auto Technologies you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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Lumax Auto Technologies
Lumax Auto Technologies Limited, together with its subsidiaries, manufactures and sells in automotive components in India.
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Solid track record with excellent balance sheet.